The 1990’s Financial Crises in Nordic Countries

1. The 1990’s Financial Crises in Nordic Countries "Financial Markets and the Macroeconomy: Challenges for Central Banks", Sveriges Riksbank, 6 November 2009 Seppo Honkapohja, Bank of Finland

2. I. Introduction • 19 crises in advanced countries since WWII before the current one. • 1990’s crises in Finland, Norway and Sweden are among the ”big five”. • In 1990-93 bank loss provisions (of lending): 2.9 % in Denmark, 3.4 % in Finland, 2.7 % in Norway 4.8 % in Sweden

3. All Nordic countries provided public support to their banks. • Crises in Finland, Norway, and Sweden became systemic. • Crisis remained non-systemic in Denmark.

4. Outline of Talk • Main developments • Reasons for the crises • Crisis management • Lessons --------------------------- • My perspective

5. II. Main DevelopmentsII.1 The Real Economies

6. Finland and Sweden • Overheating in 2nd half of 1980’s • Recession with negative growth in early 1990’s • Recovery, then good performance • Note: Finnish developments more extreme ---------------------------- • Norway had an earlier upswing, recession in 1987, but no (significant) negative growth. • Fairly slow recovery, then good performance

8. Current account • Finland had major CA deficits in 1980s and early 1990s. • Smaller but fairly persistent CA deficits for Sweden. • Norway had CA surpluses, except in 2nd half of 1980s after decline of oil prices in 1986.

9. II.2 Financial developments

11. House prices • Strong boom and subsequent decline in Finland and Norway • Long decline in Norway • less pronounced and slow movements in Sweden Stock prices • Strong movements in Finland and Sweden in late 80’s and early 90’s • Little movement in Norway during the boom and crisis

13. Bank lending (percent of GDP) • Strong increase during the 80’s boom • Major decline with the onset of the recession • Finland and Sweden had negative lending growth for 2-3 years in early 90’s.

17. III. Reasons for the Crises • Focus on Finland (deepest crisis) III. 1 Boom • Finnish boom caused by • financial market deregulation (with problematic elements) • Freeing of capital movements, with attempt to tight monetary policy under fixed exchange rate • Upswing in western economies (bad timing) • Swedish boom similar, but milder • Norway: boom cut short by oil price decline in 1986

18. III. 2 Bust • Negative international shocks • slow growth in the west • collapse of Soviet Union -> huge decline in trade with Russians • German unification led to high real interest rates (Figures) • Domestic policy • Domestic monetary policy very restrictive because of defence of fixed exchange rate • Finland started to recover in 1993-94

21. The recession was largely similar but smaller in Sweden, except Sweden had no trade with Soviet Union. • Swedish industry was also more modernized than Finnish industry. • Norway: recession in 1987-88 because of oil price decline and restrictive policies; only slow recovery

22. III. Reasons for the Crisis • Problems in financialderegulation • badtimingwith international business cycleupswing • Bank laws and bank supervision wereoutdated (tighteningonly in 1991) • taxsystemfavoreddebtfinancing • lendingratesfreedbeforedepositrates • fixedexchangeratesystem • International dimension for Finnish and Swedishcrises => ”twincrises”

23. IV. Crisis management • Finland • 1st measure: Bank of Finland took control of Skopbank in September 1991. • Public support: preferred capital certificates to banks, with strict requirements • Support to be converted into shares if not repaid • Government set up a crisis management agency. • Policy-makers made promises to guarantee banks’ obligations, also further public support.

24. Finland (continued) • Banks became profitable again in 1996 • Improved efficiency (staff halved, etc.) • Major restructuring of banking system: • savings banks largely disappeared, • one big commercial bank was merged to another • Nowadays about 60 percent of banks owned by foreigners => Biggest part of the crisis was in Savings Banks.

25. Sweden • Crisis erupted in autumn 1991 with Första Sparbanken; government gave a loan and FS merged with other savings banks. • Nordbanken (3rd largest comm. bank) was 71% govt owned and had to be recapitalized. • Many banks made heavy credit losses. • In autumn 1992 blanket creditor guarantee by government. • Crisis resolution agency set up, public support with strict criteria in risk reduction and efficiency. • Some banks did not need public support. • In the end nearly all support went into two banks, Gotabanken and Nordbanken. - Nordbanken became a pan-Nordic bank ”Nordea”.

26. Norway • Crisis erupted in autumn 1988. • Initially private guarantee funds provided support and bank mergers took place. • In late 1990 private funds were exhausted, so government guarantee funds set up in early 1991. • Support had to be converted into solvency support. • In autumn 1991 capital support needed. • In Spring 1992 several banks, incl. three biggest commercial banks were nationalized.

27. Norway (continued): • no blanket guarantee by government, but specific announcements about securing depositors and creditors • Banks situation started to improved in 1993. • One of nationalized banks was sold in 1995 and two other banks were sold later. • Government still owns 34 percent of one bank (in 2008). => In the end the Norwegian tax payer made money out of the crisis (not so in Finland and Sweden).

28. Fiscal costs of the banking crises (Sandal 2004)

29. V. Lessons • Prevention of major crisis is first priority => stability-oriented macro policies • How to diagnose an overheatingsituation? • rapidcreditexpansion • strongincrease in leverage • big externaldeficits in openeconomies • Political-economy reasons can be a major obstacle in prevention.

30. Crisis management • Maintaining confidence in banking system is crucial. • Bipartisan political support; political guarantees to banks’ obligations in Finland and Sweden but not in Norway. • Role of central banks • Liquidity support in Norway and Sweden • Bank of Finland had to take over a problem bank.

31. Crisisresolutionagencies in allthreecountries • Administrative separation from central bank and ministry of finance. • Capital injections to banks • Guiding of restructuringof the bankingsystem • Treatment of ”oldshareholders” wasmixed • Asset management companies (”badbanks”) to dealwithnon-performingassets • Norway: bankshadtheirownbadbanks • Finland and Sweden had public agencies => Nordicpractices in crisisresolutionhavebeenpraisedafterwards.